The value of diversification in an unstable market

Hello friends, and welcome to The Unsophisticated Investor! Brought to you by Scott & Rob, the founders of PitchedIt!

If you want to be one of the first to get access to some of the most exclusive private market investment opportunities in Europe, join our limited waitlist now.

Now, let’s get into it 👇

Investor or not, nobody could miss the news surrounding the current market turmoil and fears of a recession this past week. The markets took a beating over the last few days, off the back of the Japanese Yen carry trade. We don’t want to go into too much detail on that here but to explain; a carry trade is when asset managers borrow money (Yen in this instance) for little to no interest and use it to buy assets. The Japanese Central Bank has kept interest rates very low or even negative for the last 10-20 years, so asset managers were basically borrowing this money for free. They then invest this money in the markets and make a profit. They pay back the Yen and pocket the difference.

The problem is that the Japanese Central Bank raised interest rates for the first time in decades, while the US and Europe cut rates. This caused the Yen to strengthen against the dollar, forcing asset managers to deposit money to cover losses. To do this they had to sell off their positions to pay back the Yen they owed. Unwinding so many trades so fast caused stock prices to fall rapidly. This caused a domino effect made worse by fears of a US recession and worse-than-expected US job rate data.

As I write this on Tuesday morning, the markets have bounced back overnight and it seems like there could still be a soft landing ahead. But this has all got me thinking; alternative assets can protect a portfolio from the severe freefalls we witnessed yesterday!

We speak about alternative assets (also known as private markets assets) nearly every week on The Unsophisticated Investor. But it's not just Venture capital or Private Equity…which we write about most often. And it’s more than Real Estate, Private Credit or even Crypto. Alternative assets are any asset class that are not stocks, bonds or cash, and includes tangible assets like rare art and other collectables. One of the best characteristics of alternative assets is that they have a low correlation to traditional asset classes, meaning they don’t necessarily move in the same direction as other assets when market conditions change.

So what? Well, every investor felt their stomach drop when they saw the markets in free fall over the last few days. If your portfolio is made up of purely public market assets then these drops are unavoidable. And truth be told, if you’re a long term investor who doesn’t need to access their capital then you shouldn’t worry. The markets go up, the markets go down. 

However, while many of us have a long term outlook, it's never enjoyable to see half the value of your investments get wiped out overnight, and if you’re looking for some security, alternatives can soften that blow. They offer downside protection and are less correlated, often completely uncorrelated, to the market; which is great during times of uncertainty when stability is sought.

Now, how correlated the asset class is depends on the asset class itself. Venture capital is a high risk/high reward asset class that is uncorrelated from public markets. Take Covid for example. When Covid hit, public markets fell dramatically. On the other hand, many private startups benefited greatly, saw huge growth and raised fresh rounds of funding. When the market falters, liquid assets (stocks, bonds, gold, oil, bitcoin etc.) see their prices collapse as investors exit their positions in a ‘rush to dollars’. You can see the correlation here. Everything moves downward simultaneously. 

Venture capital is insulated from much of the movements in public markets because of its illiquidity. It's generally driven by outliers that grow massively over long time periods. Startup investors usually work off 10 year investment horizons, shielding them from short term market volatility. There are a number of other factors too, like the market they operate in. In many cases, startups fight for a smaller and less competitive piece of a market. Or, go after markets that only become viable when favourable tailwinds like changes to regulation or new technology allows it. In any case, startups often begin with a smaller segment that is still ignored by the incumbents - a segment that tends to be less competitive and thus less correlated to the market. 

Other asset classes like art and collectables are far removed from public markets and can also provide safety to your portfolio. Investing in rare art might sound like a world away from what you have access to as an investor but it's now readily available through platforms like Masterworks. And, unlike stocks and bonds, the art market doesn’t have a correlated response when traditional markets decline. Adding art as a small percentage of your investment portfolio improves diversification, which helps to reduce concentration risk. Ever felt like owning a Banksy (or at least a fraction of one)? Now you can!

So, while a little unnerving, the recent turmoil shouldn’t cause too much of a freakout. As I said earlier, corrections like this are a regular occurrence. Regardless, they aren’t fun and if we can avoid these drops in our portfolio then all the better. As a result of these corrections, many investors will seek alternatives to reduce the overall risk to their portfolio. The current market conditions, marked by significant declines in stocks and bonds, highlight the need for long-term diversification. If you’re feeling overly concentrated on a single asset class, then maybe this past week will be the push you needed to make some changes!

What we’ve been working on at PitchedIt

• Updated user portfolios to include more performance metrics 📊

• Many security updates to prevent a number of typical vulnerabilities 🛡️

• Refactored the header for an improved navigation experience 🧭

• More progress on creating a number of launch assets and content 🖼️

• Our brand update is edging even closer to reality 🤗

The Unsophisticated Investor is brought to you by Scott & Rob, the founders of PitchedIt. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. PitchedIt’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

Scott & Rob
PitchedIt Co-Founders